I am the Chief Economist of Zillow Inc., the leading real estate information marketplace. I have built out the industry-leading economics and analytic team at Zillow, which has been responsible for increasingly accurate versions of the Zestimate, new analytic products, and making Zillow a recognized voice of impartial, data-driven economic analysis on the U.S. housing market. Prior to Zillow, I worked at Expedia where I ran a team responsible for finding innovative ways to use data, building systems for personalization, pricing, forecasting, and fraud detection. Before Expedia, I was with NASA where I negotiated international science agreements. I also served in the United States Peace Corps, where I taught physics and chemistry classes in West Africa. I received a Bachelor of Arts from Davidson College, a Masters of Science in Foreign Service from Georgetown University, and a Ph.D. in Government from the University of Virginia.

Everybody wants credit for doing something about the housing crisis. Right now the government is hoping to convert hundreds of thousands of foreclosures owned by Fannie Mae and Freddie Mac into rentals.

Why isn’t this already happening? Or is it? I worry that we’re about to repeat earlier mistakes and create expensive market distortions that don’t produce much fundamental good.

Let me catch you up on the news. Earlier this month, the Obama administration asked private investors for ideas on turning the agencies’ stock of foreclosed homes, or REOs, into rentals. The White House had officials from the Federal Housing Finance Agency (the body charged with overseeing Fannie and Freddie), the Department of Housing and Urban Development, and the Treasury Department jointly issue an official request for ideas on how to move nearly 250,000 unsold repossessed homes it acquired through foreclosure from the for-sale market to the rental market. According to the press release, the hope is that pooling these REOs would reduce credit losses for Fannie and Freddie and stabilize neighborhoods as a result.

On the surface, it sounds great. We could help the housing market by getting rid of some of the foreclosure inventory while creating rental options for a lot of homeowners who are being displaced by foreclosure.

But what, precisely, is the market impediment that we’re trying to fix here? Yes, we have a very large supply of foreclosed homes courtesy of a wrenching, multi-year housing recession. And home prices are still falling. But the flip side of the horrible purchase market is a booming rental market. Rental supply is reportedly as tight now as it was prior to the recession, and effective rents are estimated to rise 4% this year. Likewise, the foreclosure epidemic is converting lots of homeowners into renters, thus increasing rental demand.

Investors smell a distinct opportunity here: the chance to buy an asset cheaply and rent it out dearly. About 30% of the purchases of existing homes this year have been going to all-cash buyers, the bulk of whom are real estate investors. For the most part, these have been small, private investors buying properties one by one with the intention of leasing them out.

This natural market dynamic does seem to be making some headway. In the second quarter, Fannie sold more REO properties than it acquired. That means its REO backlog has finally started to subside. In fact, the combined inventory of REOs owned by Fannie, Freddie and the Federal Housing Administration (FHA) declined at the end of the first quarter compared to the previous quarter.

Granted, part of the reason that REO sales are finally outpacing REO acquisitions is the slowdown in the foreclosure process. So it is likely that inventory levels will start to rise again once the foreclosure pace ramps back up. But the point still holds that Fannie, Freddie and the FHA are disposing of REOs at a record pace.

This is what a market-clearing process looks like. Rental demand may soon outpace supply, which will bid up rent prices. This, in turn, will create the incentives for even more investors to snap up cheap foreclosures and convert them to rentals. It’s painful for people who lose homes along the way. It’s not always pretty or fast for the rest of us. But it is natural.

Can the government help speed along this process? Maybe. But the first order is definitely making sure that we don’t do the market any further harm. For example, any plan in which the government-sponsored enterprises (GSE) retain ownership of the homes while renting them out just seems nonsensical. These homes will presumably have to be ultimately sold, so continued direct ownership perpetuates shadow inventory which undermines buyer confidence in price stability. The rentals will also directly compete with private investors who bought distressed properties in hopes of capitalizing on strong rental demand. Instead these investors would be thrown into competition with the GSEs.

Post Your Comment

Post Your Reply

Forbes writers have the ability to call out member comments they find particularly interesting. Called-out comments are highlighted across the Forbes network. You'll be notified if your comment is called out.